Audits, Reputation, and Repeated Interaction in a Capital Budgeting Setting

The experimental study presented in this paper explores the effects of ex post audits in capital budgeting processes under different informational and social circumstances. Audits are analyzed in one-shot settings with different preplay information about superior and subordinate as well as under repeated interaction. Consequently, we are able to distinguish between effects of reputation building by the superior and by the subordinate. Moreover, we separate effects of social interaction between the two parties from purely informational effects. This is important as long-term relationships differ from one-shot interactions both with respect to informational and social issues. We find that audits are beneficial for the superiors as audits decrease slack and increase the superior payoff. However, this result is driven by the treatments with one-shot interaction. Surprisingly, in these treatments, only information about the subordinate significantly reduces slack and increases the superior payoff. Finally, we find that social interaction between the two parties plays an important role in the repeated setting as slack strongly increases and the superior payoff strongly decreases relative to the one-shot setting with full information. Our further analysis reveals that this might be due to the fact that audits introduce mistrust into the superior-subordinate relationship.